General

The following is a discussion of the Company's financial condition and liquidity and results of operations. Certain aspects of the Company's business have loss experience characterized as low frequency and high severity. This may result in volatility in both the Company's and an individual segment's results of operations and financial condition.

This "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains forward-looking statements that involve inherent risks and uncertainties. Statements that are not historical facts, including statements about the Company's beliefs and expectations, are forward- looking statements. These statements are based upon current plans, estimates and projections. Actual results may differ materially from those included in such forward-looking statements, and therefore undue reliance should not be placed on them. See "Cautionary Note Regarding Forward-Looking Statements" below for a list of factors that could cause actual results to differ materially from those contained in any forward-looking statement.

This discussion and analysis should be read in conjunction with the "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the audited Consolidated Financial Statements and notes thereto, presented under Item 7 and Item 8, respectively, of the Company's Annual Report on Form 10-K for the year ended December 31, 2007.

Executive Overview

See "Executive Overview" in Item 7 of the Company's Form 10-K for the year ended December 31, 2007.

Results of Operations

The following table presents an analysis of the Company's net (loss) income
available to ordinary shareholders and other financial measures (described
below) for the three months ended September 30, 2008 and 2007:


(U.S. dollars and shares in thousands, except per                      (Unaudited)
share amounts)                                                     Three Months Ended
                                                                      September 30,
                                                                2008                   2007
Net (loss) income available to ordinary shareholders      $     (1,649,024 )       $   327,975
(Loss) earnings per ordinary share and ordinary
share equivalents - basic                                 $          (6.09 )       $      1.83
(Loss) earnings per ordinary share and ordinary
share equivalents - diluted                               $          (6.09 )       $      1.82
Weighted average number of ordinary shares and
ordinary share equivalents - basic                                 270,844             178,788
Weighted average number of ordinary shares and
ordinary share equivalents - diluted                               270,844             179,781

(U.S. dollars and shares in thousands, except per                      (Unaudited)
share amounts)                                                      Nine Months Ended
                                                                      September 30,
                                                              2008                     2007
Net (loss) income available to ordinary
shareholders                                            $     (1,199,300 )        $     1,422,228
(Loss) earnings per ordinary share and ordinary
share equivalents-basic                                 $          (5.75 )        $          7.95
(Loss) earnings per ordinary share and ordinary
share equivalents-diluted                               $          (5.75 )        $          7.89
Weighted average number of ordinary shares and
ordinary share equivalents-basic                                 208,437                  178,886
Weighted average number of ordinary shares and
ordinary share equivalents-diluted                               208,437                  180,340

The Company's net (loss) income and other financial measures as shown below for the three and nine months ended September 30, 2008 have been affected by, among other things, the following significant items:

1) Agreement with Syncora with Respect to Pre-IPO Guarantees and Reinsurance Agreements and Service Agreements

On July 28, 2008, the Company announced that it and certain of its subsidiaries had entered into an agreement (the "Master Agreement") with Syncora and certain of its subsidiaries (sometimes collectively referred to herein as "Syncora") as well as certain counterparties to credit default swap agreements (the "Counterparties"), in connection with the termination of certain reinsurance and other agreements. The transactions and termination of certain reinsurance and other agreements under the Master Agreement closed on August 5, 2008. For a description of the Master Agreement, see Note 4 to the Consolidated Financial Statements, "Syncora Holdings Ltd. ("Syncora")."

After the closing of the Master Agreement on August 5, 2008, approximately $64.6 billion of the Company's total net exposure (which was $65.7 billion as at June 30, 2008) under reinsurance agreements and guarantees with Syncora subsidiaries was eliminated. Pursuant to the terms of the Master Agreement, Syncora is required to use commercially reasonable efforts to commute the agreements that are the subject of the Company's guarantee of Syncora Guarantee's obligations under certain financial guarantees issued by Syncora Guarantee to the European Investment Bank (the "EIB Policies"), subject to certain limitations. As at September 30, 2008, the Company's exposures relating to the EIB Policies (which relate to project finance transactions) was approximately $1.0 billion reduced from $1.1 billion at June 30, 2008 mainly due to the strengthening of the U.S. dollar against the currencies of the underlying obligations. As of September 30, 2008, there have been no reported events of default on the underlying obligations, accordingly, no reserves have been recorded.

The terms of the Master Agreement were determined in consideration of a number of commercial and economic factors associated with all existing relationships with Syncora, including, but not limited to, a valuation of the consideration for the commuted agreements and any potential future claims thereunder and the impact of outstanding uncertainty on both the ratings and business operations of the Company. The total value of the consideration noted above of $1.775 billion as well as the eight million ordinary shares of the Company transferred to Syncora valued at $128.0 million, significantly exceeded the carried net liabilities of approximately $490.7 million related to such reinsurances and guarantees. Management considers the execution of the Master Agreement as the event giving rise to the additional liability. As detailed in the table below, the Company

(U.S. dollars in millions)
Carried liabilities in relation to reinsurance and guarantee
agreements commuted under the Master Agreement as at June 30,
2008                                                                  $      490.7
Other accruals                                                                (5.2 )
Cash payment made to Syncora in August 2008                               (1,775.0 )
Value of XL common shares transferred under the Master Agreement            (128.0 )

Net loss associated with Master Agreement recorded in the three
months ended September 30, 2008                                       $   (1,417.5 )

2) The impact of Hurricanes Gustav and Ike

On September 1, 2008, Hurricane Gustav hit the Louisiana coast of the U.S. as a Category 2 hurricane, causing considerable damage to insured property and loss of life. On September 13, 2008, Hurricane Ike made landfall near Galveston, Texas as a strong Category 2 hurricane, causing significantly more damage and loss of life than Hurricane Gustav. Based on market estimates, Hurricane Ike is estimated to have caused the third largest ever insured loss in the U.S. from a wind storm.

Combined, Hurricanes Gustav and Ike had a significant impact on the results of the Company for the three and nine month periods ended September 30, 2008. The Company has estimated losses incurred, net of reinsurance recoveries and reinstatement premiums, of $27.4 million and $194.4 million related to Hurricanes Gustav and Ike, respectively, based on preliminary reports and estimates of loss and damage. The Company performed an analysis of contracts it believes are exposed to Hurricanes Gustav and Ike, and together with preliminary information received from insureds and cedants as well as commmercially developed industry models, determined its current best estimate for the expected ultimate loss. Actual losses may vary from this estimate based on a number of factors, including receipt of additional information from insureds and brokers, the attribution of losses to coverages that had not previously been considered as exposed and inflation in repair costs due to additional demand for labor and materials.

3) Impact of credit market movements on the Company's investment portfolio and investment fund affiliates

In the first nine months of 2008, particularly in the first and third quarters, financial market conditions continued to be extremely challenging as the global credit crisis that began in July 2007 continued to adversely impact global markets. This unprecedented market volatility directly and materially affected the Company's results of operations and investment portfolio during the quarter ended September 30, 2008. The fixed-income markets experienced a period of extreme volatility during such quarter, negatively impacting market liquidity conditions. As a result, the market for fixed-income instruments experienced decreased liquidity, increased price volatility, credit downgrade events, and increased probability of default. Domestic and international equity markets also experienced heightened volatility and turmoil during this period.

During the first quarter of 2008, the Company reported significant decreases in asset values in respect of the Company's holdings of sub-prime non-agency securities, second liens, ABS CDOs with sub-prime collateral as well as Alt-A mortgage exposures ("Topical Assets"). While credit spreads on both corporate and structured credit rallied modestly in the second quarter of 2008, during the third quarter of 2008 there was unprecedented widening of corporate credit spreads particularly in the financial sector. While there was some continued asset value deterioration in the Company's structured credit portfolio, primarily in commercial mortgage-backed securities ("CMBSs"), core collateralized debt obligations ("CDOs") and Alt-A's, as well as moderate benefit from declining interest rates, the primary driver of movements in the Company's invested asset values in the third

The following table provides further details regarding the extreme volatility in the global credit markets, as well as in government interest rates using some sample market indices:

                 Interest Rate Movement for the   Credit Spread Movement for the
                 three months ended September     three months ended September
                 30, 2008 (1)                     30, 2008 (2)
United States    - 35 basis points (5 year        + 199 basis points (US
                 treasury)                        Corporate A rated)
                                                  + 11 basis points (US RMBS,
                                                  AAA rated)
                                                  + 181 basis points (US CMBS,
                                                  AAA rated)
United Kingdom   - 68 basis points (10 year       + 84 basis points (UK
                 Gilt)                            corporate, AA rated)
Euro-zone        - 87 basis points (5 year        + 139 basis points (Europe
                 Bund)                            Corporate, A rated)
                 Interest Rate Movement for the   Credit Spread Movement for the
                 nine months ended September      nine months ended September
                 30, 2008                         30, 2008

United States    - 46 basis points (5 year        + 274 basis points (US
                 treasury)                        Corporate A rated)
                                                  + 43 basis points (US RMBS,
                                                  AAA rated)
                                                  + 285 basis points (US CMBS,
                                                  AAA rated)
United Kingdom   - 6 basis points (10 year        + 122 basis points (UK
                 Gilt)                            corporate, AA rated)
Euro-zone        - 35 basis points (5 year        + 190 basis points (Europe
                 Bund)                            Corporate, A rated)

(1) Source: Bloomberg Finance L.P.

(2) Source: Merrill Lynch Global Index

The net impact of the market conditions over the course of 2008 on the Company's investment portfolio for the first nine months of the year has resulted in realized losses of $393.1 million and an increase in net unrealized losses on available-for-sale investments of $2.6 billion. This represents approximately a 9.3% deterioration on average assets for the nine months ended September 30, 2008. See Item 1A. Risk Factors "Deterioration in the public debt and equity markets could lead to additional investment losses" below. In addition, see "We are exposed to significant capital markets risk related to changes in interest rates, credit spreads, equity prices and foreign exchange rates which may adversely affect our results of operations, financial condition or cash flows" in the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2008. Since the time of the Company's August 2008 public offering of ordinary shares and equity security units (See "Capital Management" below), the volatility and disruption in the global capital markets have reached unprecedented levels and substantially increased during the third quarter of 2008.

Corporate credit portfolio

The following table details the Company's corporate credit exposures by certain asset classes as well as ratings levels within the Company's fixed maturity portfolio and the current net unrealized (loss) position as at September 30, 2008:

(U.S. dollars in millions)                AAA                     AA                     A                     BBB                 BB & Below                Total
Financials
Fair value                           $       750.3          $     1,809.0          $     2,179.9          $       374.3          $      113.1           $      5,226.6
Net unrealized gain (loss)           $       (36.3 )        $      (225.9 )        $      (597.7 )        $      (115.4 )        $      (28.3 )         $     (1,003.6 )
Non-Financials
Fair value                           $       577.2          $       695.7          $     2,374.7          $     1,612.1          $      609.6           $      5,869.3
Net unrealized gain (loss)           $       (41.3 )        $       (63.4 )        $      (257.2 )        $      (186.9 )        $      (96.0 )         $       (644.8 )
Total
Fair value                           $     1,327.5          $     2,504.7          $     4,554.6          $     1,986.4          $      722.7           $     11,095.9
Net unrealized gain (loss)           $       (77.6 )        $      (289.3 )        $      (854.9 )        $      (302.3 )        $     (124.3 )         $     (1,648.4 )

Structured credit portfolio

The following tables details the Company's structured credit exposures by certain asset classes as well as ratings levels within the Company's fixed maturity portfolio and the current net unrealized gain (loss) position as at September 30, 2008:

(U.S. dollars in millions)                 AAA                 AA                 A                 BBB              BB & Below               Total
CMBS
Fair value                            $   2,342.6         $      9.2         $     22.3         $     18.4          $      17.2          $      2,409.7
Net unrealized gain (loss)            $    (264.5 )       $     (1.8 )       $     (4.4 )       $     (3.7 )        $      (5.1 )        $       (279.5 )
Prime RMBS
Fair value                            $   2,925.1         $     61.9         $     62.3         $     23.9          $      19.5          $      3,092.7
Net unrealized gain (loss)            $    (165.2 )       $    (11.5 )       $     (8.6 )       $     (3.3 )        $      (0.8 )        $       (189.4 )
Topical Assets
Fair value                            $     798.0         $    312.9         $     67.1         $     58.6          $      34.0          $      1,270.6
Net unrealized gain (loss)            $    (251.5 )       $   (113.4 )       $    (49.7 )       $      5.3          $     (21.2 )        $       (430.5 )
Core CDO (1)
Fair value                            $     216.4         $    352.7         $     53.3         $    126.7          $       8.4          $        757.5
Net unrealized gain (loss)            $     (44.1 )       $   (177.4 )       $    (29.8 )       $   (122.9 )        $      (5.2 )        $       (379.4 )
Other Asset & Mortgage Backed
Securities
Fair value                            $   1,437.3         $    165.1         $    306.9         $     73.0          $      32.7          $      2,015.0
Net unrealized gain (loss)            $     (46.1 )       $    (20.8 )       $    (50.0 )       $    (15.2 )        $       4.2          $       (127.9 )
Total
Fair value                            $   7,719.4         $    901.8         $    511.9         $    300.6          $     111.8          $      9,545.5
Net unrealized gain (loss)            $    (771.4 )       $   (324.9 )       $   (142.5 )       $   (139.8 )        $     (28.1 )        $     (1,406.7 )

(1) The Company defines Core CDOs as investments in non-mortgage collateralized debt obligations, primarily consisting of collateralized loan obligations.

The following table details the current exposures to Topical Assets within the Company's fixed income portfolio as well as the current net unrealized (loss) gain position as at September 30, 2008 and December 31, 2007:

(U.S. dollars in thousands)                                     As at                                                              As at
                                                          September 30, 2008                                                 December 31, 2007
                                                               Percent                                                            Percent
                                                               of Fixed                Net                                        of Fixed                Net
                                        Holding at              Income             Unrealized              Holding at              Income             Unrealized
                                        Fair Value            Portfolio            (Loss) Gain             Fair Value            Portfolio            (Loss) Gain
Topical Assets:
Sub-prime first lien mortgages        $       659,378               2.0 %        $     (200,909 )        $       995,947               2.5 %        $     (145,785 )
Alt-A mortgages                               525,424               1.6 %              (227,424 )                924,783               2.3 %               (40,145 )
Second lien mortgages (including
sub-prime second lien mortgages)               71,129               0.2 %                 3,281                   97,647               0.3 %                   788
ABS CDOs with sub-prime
collateral                                     14,638               0.0 %                (5,324 )                 39,317               0.1 %                   101

Total exposure to Topical Assets      $     1,270,569               3.8 %        $     (430,376 )        $     2,057,694               5.2 %        $     (185,041 )

Of the total Topical Assets with fair value exposure as at September 30, 2008 and December 31, 2007 of $1.3 billion and $2.0 billion, respectively, approximately $50.0 million and $76.8 million, respectively, of the related securities had ratings dependent on guarantees issued by third party guarantors (i.e., monoline insurers). Decreases in the ratings of such third party guarantors would typically decrease the fair value of guaranteed securities; however, at September 30, 2008, in the event of non-performance at such date on the part of these third party guarantors, the Company estimated that the average credit quality of this portfolio would be 'A' and that approximately 95.6% would have remained investment grade at such date. In addition, of the total fixed income portfolio as at September 30, 2008 and December 31, 2007, of $33.4 billion and $39.1 billion, respectively, less than 2% were guaranteed by such third parties with no individual third party representing more than 1%.

At September 30, 2008, the Company's sub-prime and Alt-A exposures remained primarily highly rated, had strong underlying loan characteristics and the Company believed at such date that they were supported by adequate subordination levels based on current expectations of house price declines, loss severities and default levels. The Company had approximately $159 million of Topical Assets downgraded during the quarter ended September 30, 2008 and approximately $427 million during the nine months ended September 30, 2008.

Liquidations necessary to fund the repayment of the guaranteed investment contract ("GIC") liabilities following the downgrade of Syncora Guarantee and the maturity of certain funding agreements were funded through sales of assets in the Other Financial Lines segment investment portfolios as well as the general investment portfolio. Management's approach was to avoid the sale of assets where current market prices did not reflect intrinsic values or where transaction costs for liquidation were excessive. As a result, the Company continues to hold a number of the Topical Assets and these have been transferred to the general portfolio in exchange for those assets that were liquidated.

Realized losses and other than temporary impairments

During the three and nine month periods ended September 30, 2008, net realized losses of $252.6 million and $415.1 million, respectively, related to the write-down of certain of the Company's fixed income and equity investments, including securities of Lehman, where the Company determined that there was an other than temporary decline in the value of those investments. Management's analysis of the remaining securities in unrealized loss positions at September 30, 2008 indicated that these assets will ultimately pay out all expected cash flows and that the Company had at such date the intent and the ability to hold them until recovery.

Included in the impairment charge for the third quarter ended September 30, 2008, was approximately $117 million of related exposures to financial institutions, primarily related to Lehman. The remaining third quarter impairment was spread across the portfolio including structured credit, equity and other fixed income investments, with $67.9 million related to securities

The following table provides the earnings and comprehensive earnings impact related to the Topical Assets in the three and nine months ended September 30, 2008:

(U.S. dollars in thousands)                          Three Months Ended                            Nine Months Ended
                                                     September 30, 2008                           September 30, 2008
                                                                      Change                                        Change
                                                Realized              in Net               Realized                 in Net
                                               (Loss) and           Unrealized            (Loss) and              Unrealized
                                             (Impairments)            (Loss)             (Impairments)              (Loss)
Topical Assets:
Sub-prime first lien mortgages               $     (27,129 )       $    11,460          $      (43,018 )        $      (55,124 )
Alt-A mortgages.                                   (35,552 )           (52,919 )               (64,238 )              (187,279 )
Second lien mortgages (including
sub-prime second lien mortgages)                    (1,921 )            10,842                 (25,352 )                 2,493
ABS CDOs with sub-prime collateral                  (2,319 )              (467 )                (9,000 )                (5,425 )

Total                                        $     (66,921 )       $   (31,084 )        $     (141,608 )        $     (245,335 )

All portfolio holdings, including those with sub-prime exposure, are reviewed as part of the ongoing other than temporary impairment monitoring process. The Company continues to actively monitor its exposures, and to the extent market . . .